Ask an RU: How do I Calculate Rental Income for Primary Residence Conversions?

Rental income has been a popular guideline topic over the last year. Obtaining the required documentation and accurately determining the amount of rental income that can be considered can have a significant impact on a borrower’s ability to qualify. Since rental income is a broad topic, we’ll focus on one of the most common scenarios in this installment. This occurs when a borrower is purchasing a new primary residence and converting their current primary into an investment property.

Robert Grolemund, Regional Underwriter at Enact, dives into everything you need to know to help you effectively navigate rental income calculation when your borrower converts their home into a rental property.

Documenting rental income

In this scenario, establishing whether the borrower has property management experience is a major factor in determining the amount of rental income that can be considered. Fortunately, Fannie Mae guidelines and Freddie Mac guidelines are currently aligned on this topic. See the following information for documentation requirements and the amount of rental income that can be considered.

A fully executed lease agreement is required, and

• Form 1000/1007 or form 72/1025, as applicable, or
• Documentation verifying documented proof that the lease has gone into effect; by verifying receipt of the security deposit and the first month’s rent or two consecutive months of rental payments have been paid to the borrower.

Documentation may include:

• Evidence that the payments were cashed or deposited into the Borrower’s depository account at a financial institution (e.g., bank statements evidencing deposit or canceled checks), or
• Evidence that the payments were transferred into a third-party money transfer application account that is owned by the Borrower (e.g., a screen shot or monthly account statement evidencing transfer of the payments and the Borrower’s name, a screen shot that evidence transfer of the payments and ties the account to the Borrowers bank account), or
• For security deposits, evidence of deposit into an escrow or business account established for this purpose, or evidence payment was cashed or deposited into the Borrower’s personal depository account at a financial institution.

Calculating qualifying rental income (or loss):

What counts as rental income and what is the best way to calculate it? We cover an overview below:

• Use 75% of the gross monthly rent or gross market rent (the remaining 25% of the gross rent will be absorbed by vacancy losses and ongoing maintenance expenses).
• If the borrower has less than one-year of documented property management experience, rental income is limited to an offset of the PITIA (principal, interest, taxes, insurance, and association fees). No additional income can be considered.
• If at least one borrower has a minimum of one-year of documented property management experience, there are no restrictions on the amount of rental income that can be used.
• Any rental income loss will need to be included as a monthly obligation when calculating the debt-to-income ratio (DTI).

Impacts of property management experience on rental income calculation

To reiterate, property management experience is a major factor in determining the amount of rental income that may be considered for qualifying purposes. Property management experience can be demonstrated by obtaining one of the following:

• The borrower’s most recent signed federal income tax return, including Schedules 1 and E. Schedule E should reflect rental income received for any property and Fair Rental Days of 365;
• If the property has been owned for at least one year, but there are less than 365 Fair Rental Days on Schedule E, a current signed lease agreement may be used to supplement the federal income tax return; or
• A current signed lease may be used to supplement a federal income tax return if the property was out of service for any time period in the prior year. Schedule E must support this by reflecting a reduced number of days in use and related repair costs. Form 1007 or Form 1025 must support the income reflected on the lease.

Here are some example calculations to help you better navigate this income scenario.

(Example Calculation) Borrower with one year property management experience:

• Gross Monthly Rent: $3000
• Net Rental Income: $3000 x .75 = $2250
• PITIA: $2000

Result: $2250 – $2000 = $250 (this $250 can be added to the borrower’s monthly income)

(Example Calculation) Borrower without one year property management experience:

• Gross Monthly Rent: $3000
• Net Rental Income: $3000 x .75 = $2250
• PITIA: $2000

Result: The $250 cannot be added to the income; instead, it reduces the PITIA to zero for DTI calculation but does not count as additional income.

For borrowers with one year of property management experience, 75% of the gross monthly rent can be added to their monthly income after deducting the PITIA. For those without one year of experience, the rental income can only offset the PITIA but cannot be added as additional income.

GSE guidelines and rental income calculation

Refer to Fannie Mae guidelines and Freddie Mac guidelines on a regular basis to ensure compliance and stay up to date on requirements. Plus, you can always access these resources and help yourself out by bookmarking them to reference later.

Every borrower scenario is unique! That’s why it’s important to remember that harnessing rental income from a departure property can significantly impact a borrower’s ability to qualify. Understanding the complexities of rental income from a departure property can help you reduce underwriting conditions and avoid potential qualification issues. Want to learn more about primary residence conversion red flags to help you avoid misrepresentation on your future loans? Check out some QA trends from a recent blog here (and access the most up to date QA trends on our website)!

More Ways We Can Help

Your Enact MI team has got you covered. They can answer any of your important questions about rental income calculation, other borrower scenarios, and provide you with underwriting best practices! Our Regional Underwriting Team is available to assist you Monday-Friday 8am to 8pm ET at 800-444-5664 option 2.

Be sure to make the most of your MI experience, too. Please explore our many underwriting resources and underwriting tips for more information. Because going the extra mile comes easy for us, we also offer a comprehensive suite of training resources to help boost your industry experience. And don’t forget to utilize our income calculation tools if you come across different income types on your mortgage loans.

Source:  Robert Grolemund is a Regional Underwriter for Enact.

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